Appendix 1: Materials used by Messrs. Wilcox, Elmendorf, and Reinhart
February 1-2, 2005 137 of 177
RESTRICTED CONTROLLED (FR) CLASS I (FOMC) Material for Board Staff Presentation on:
Considerations Pertaining to the Establishment of a Specific, Numerical, Price-Related Objective for Monetary Policy Divisions of Research & Statistics and Monetary Affairs February 1, 2005
February 1-2, 2005 138 of 177
February 1-2, 2005 139 of 177
Exhibit t
A Specific, Numerical, Price-Related Objective for Monetary Policy?
Inflation Rates GDP chain price index peE chain price index CPI (current methods)
Four-quarter percent change
2·1-05
12
10
8
6
4
2
K----1~--~------------------------------------------------------~ 0
Key characteristics of a specific, numerical, price-related objective:
• Numerical rather than qualitative;
• Stated in terms of a particular published index; and
• Either inflation control or price-level control.
A premise of the paper:
• A price objective should be chosen to minimize the costs of deviations from price stability.
• The premise suggests that the objective should be defined with respect to the price index most closely related to such costs.
February 1-2, 2005 140 of 177
Exhibit 2
Potential Benefits and Costs of Adopting a Specific Price-Related Objective
Potential Benefits:
• Could help preserve the present commitment to price stability.
• Could better anchor long-run inflation expectations and thereby reduce the volatility of both inflation and real activity.
• Could improve public understanding of monetary policy.
• Could help focus policy debates within the FOMC.
Potential Costs:
• Could mislead the public into believing that emphasis had shifted toward the price objective.
• Could cause the FOMC inadvertently to place more emphasis on the price objective.
• Could diminish the FOMC's credibility when inflation differed from the stated objective.
• Could constrain future actions of the FOMC in an unhelpful manner.
Empirical Evidence:
• Little to no evidence regarding the likely influence on FOMC decision-making or the quality of communications with the public.
• Some hints from foreign experience that specific price objectives have helped anchor long-term inflation expectations.
• Disputed evidence that the reduced volatility of inflation and real output owes to improved conduct of U.S. monetary policy.
• Simulation-based evidence that better-anchored inflation expectations would reduce the volatility of inflation and real output.
2·1-05
February 1-2, 2005 141 of 177
Exhibil3
Operational Issues Related to Specifying a Numerical Price-Related Objective
A checklist for policymakers:
• Which price index?
• The inflation rate or the price level?
• What average rate?
• Point objective or range?
If an inflation objective, at what rate?
For index, we favor consumer prices on the grounds of:
• Familiarity_
• Quality of measurement
• Empirical result that inflation rates move together in the long run.
• Measurement bias: Nearly 1 percentage point for CPI; about % percentage point for PCE prices.
• Rationales for aiming for zero true inflation: Traditional costs of inflation.
• Rationales for aiming for positive true inflation: Downward nominal wage rigidity; zero lower bound on nominal interest rates.
Effect of zero lower bound under an updated Taylor rule:
Fraction of time with funds rate at zero
Standard deviation of output gap'
Standard deviation of unemployment rate'
'measured in percentage points
Target PCE inflation rate (measured rate, with
bias-adjusted rate in parentheses)
% (0)
.16
2.53
1.40
1 % (1)
.10
2.31
1.27
2 % (2)
.06
2.21
1.22
2-1-05
February 1-2, 2005 142 of 177
Exhibit 4
Accuracy in Achieving an Inflation Objective
Imperfect controllability:
• Inflation is volatile, and monetary policy influences it only indirectly and with a lag.
• The FOMC could not hit a point objective precisely or guarantee a narrow range.
Percent of time that peE inflation averaged over four quarters could be held within ± 1 percentage point of desired rate:
Total Core
Volatility of economic shocks matters:
1. Drawn from 1968 to 2004 experience 59 64
2. Drawn from 1984 to 2004 experience 68 73
Expectations formation matters:
3. VAR-based expectations with imperfect credibility 68 73
4. VAR-based expectations with perfect credibility 80 89
Summary:
• The FOMC could likely keep four-quarter total PCE inflation within a ± l-percentage-point band about to % of the time.
2·1-05
February 1-2, 2005 143 of 177
Exhibit 5 2-t-05
Governance Issues Related to the Specification of Price Stabilty
Is an explicit numerical 1 specification of price stability
helpful? /"-.
~ YES
Continue the status quo_
At the margin, the FOMC could: Should the objective be
2 made public?
• encourage participants to be more specific about preferences;
- use the minutes, testimonies, and the MPR to provide additional YES guidance to the public_
~ \ Agreement on a private Should the objective be decided
objective may facilitate internal by the Congress (by amending
communications, but the Federal Reserve Act) or by 3 the FOMC?
how can the FOMC justify keeping it secret?
~\roNG~ how will the FOMC keep it secret?
~ Is the FOMC:
. comfortable in seeking amendment to the FRA?
How will the FOMC choose an . confident that the Congress would 4 inflation objective? pick an appropriate inflation objective?
/ -----------And will this lead to the creation of a numerical objective for output growth or employment as well?
7 ------------5 As a group decision, similar As individual decisions,
to choosing a range for a summarized by announcing the
monetary aggregate_ range and central tendency of participants' views_
February 1-2, 2005 144 of 177
ExhibitS
Key Questions for Today's Discussion
How do you define price stability?
• Is it known by inference about behavior of by a numerical specification?
• If the latter,
• What price index do you prefer?
• Should the objective be stated in terms of a path for the price level or as the rate of inflation?
• What are the desired point estimates or ranges for the inflation objective?
What role should the price objective play in the Committee's policy process?
• Alternative I: Maintain the status quo
• Perhaps provide more information to the public over time as to your attitudes toward prevailing and prospective inflation
• Alternative II: Vote formally on a numerical inflation goal
• Alternative III: Survey participants as to the appropriate inflation objective
2-1-05
Appendix 2: Materials used by Mr. Kos
February 1-2, 2005 145 of 177
Current U.S. 3-Month Deposit Rates and Rates Implied by Traded Forward Rate Agreements
December 1, 2004 - January 31, 2005 t LIBOR Fixing 3M Forward 6M Forward 9M Forward
I1 NIT 12 14 OM 4 Minmws 7 NFP 112K 25 bps Release 57K
. . -
2 1 1213 12 2-Year Treasury Yield
December 1, 2004 - January 31, 2005It
1
Percen 3.4
3.2 -
2.8 +-
12/1 12/13 12/25 1/6 1/18 1/30
Yield Spread Between 2-and 10-Year Treasury Notes
December 1, 2004 - January 31, 2005 Basis Points Basis Points 140 , ,- 140
12 14 FO1C .25 bps
I 4 finutes Release
12 114 FOMC S25 bps
1 4 Mines Release
25
Percent Percen T 3 .4 4 .5 -1
3.2 4.3
3.0 4.1
1/6 1118 1 10-Year Treasury Yield
December 1, 2004 - January 31, 2005
12 14 FONC 25 ps
I 4 Inuls Reclease
Percent T 4.5
3.9 -- r i 3.9
12/1 12/13 12/25 1/6 1/18 1/30
Yield Spread Between 10- and 30-Year Treasury Notes
December 1, 2004 - January 31, 2005 Basis Points Basis Points 901 141i t 90
120 70
100 50
I16 1118 1/30
2 14FOMC 25 bps
30+- 1 T
12 I 1213 12/25 1/6 1 18 1 30
Page I
Percen
4.00
3.50
3.00
2.50
-9
Percent
4.00
3.50
3.00
2.50
2.00
F T ~
t
(nu es Release
12/1 12 13 12125
February 1-2, 2005 146 of 177
10-Year Swap Spread June 30, 2004 - January 28, 2005
Basis Points Basis Points 52 52
48 - 48
44 44
40 40
36 36
Basis Points 50
45
40
35
20
MBS Spreads June 30, 2004 - January 28, 2005
630 7 30 830 9130 1030 1130 1230
Investment Grade Corporate Debt Spreads June 30, 2004 - January 28, 2005
Basis Poi
7 5 7 30.' ' 9
6,,30 71/30 8/30 9/30 10/30 111/30 12/30
6/30 7/30 8/30 9/30 10/30 1130 1230
High Yield and EMBI+ Spreads June 30, 2004 - January 28, 2005
nts Basis Points Basis Points 105 520 1 r 520
100 480
95 440
90 400
85 360
80 320
75 280 "o""c: nICITII Lx fcir iior
630 7/30 8/30 9'30 10/30 11 30 12/30
Implied Swaption Volatility May 3, 1999 - January 28, 2005
I lonth \ olatility on 10-Year sw' aption
Page 2
Basis Points 50
45
40
35
30
Basis Points
Percent
15
12
9
6
Percent
15
12
9
6
1.33 N Nay'99 Nov ')9 May-00 Nov-00 May-01 Nov-01 Mav-02 Nov-02 MayV03 Nov-03 May-04 Nov-04
February 1-2, 2005 147 of 177
Page 3
Percent
2.60 - 2 3IT' :+112K
2.50
4A:
Euro-Area 3-Month Deposit Rates and Rates Implied by Traded Forward Rate Agreements
December 1, 2004 - January 3 1, 2005 LIBOR Fixing 3M Forward 6M Forward 9M For
12 14 FOM( 1 4 mues 17 NIP 5 bps Release I57K
ward Percent
T 2.60
--'
- 2.50
-2.40
2.30
2.20
2.10
12"1 12 13 12/25 Euro-Dollar Currency Pair
December 1, 2004 - January 31, 2005 S per Euro S per Euro
1.38 ,1 ... . 1., r 1.38
1 6 1118 1130 Dollar-Yen Currency Pair
December 1, 2004 - January 31, 2005 Yen per S Yen per S
106 1 r c r 106
1.36 105
1.34 104
1.32 103
1.30 102
1.28 10112/1 12/13 12 25 1/6 1/18 I30
Dollar-Yuan Exchange Value Implied by the NDF Market
July 1, 2004 - January 31, 2005 Yuan per Dollar Yuan per Dollar
8.4 -1 U , 11-:S n -. .1 r 8.4
Sep-0
12/1 12/13 12/25 1/6 1/18 1/30
Foreign Exchange Reserves of China & Japan December 3 1, 2003 - December 31, 2004
USD Billions 900 -1
800
700
600
500
7.7 40 f
Dec
USD Billions r 900
Japan
800
700
600
500
4r0
-03 Mar-04 Aun-04 Sep-04 Dec-04
7.7 -1 Jul-04 .an-05
%! * y .1
February 1-2, 2005 148 of 177
Current Account Balances (CAB) at the Bank of Japan and the Overnight Call Rate
April 30, 1998 - December 31, 2004 Yen, trillions Basis points
L zIRP oA Source 3oJ 50
Apr- Apr- Apr- Apr- Apr- Apr- Apr98 99 00 01 02 03 04
1-month Rolling Average of the 3-month Bill Auction History
April 30, 2002 - January 19, 2005 trillions Bid-to-Cover Ratio
_700
Oct-02 Apr-03 Oct-03 Apr-04 Oct-04
Bid-to-Cover on BoJ Outright Purchases of FB/TBs
April 8, 2004 - January 13, 2005
0 +
Apr-02
Ven, tri 30
10 5
0 0
Page 4Japanese Call Market
Uncollateralized Amount Outstanding January 4, 1999 - January 28, 2005
llions Yen, trillions 30
Jan- Oct- Jul- Apr- Jan- Oct- Jul99 99 00 01 02 02 03
Apr- Jan04 05
BoJ Securities Holdings July 31, 1996 - December 31, 2004
Yen, trillions 70 T
600 60 50
500 40
400 30
300 20 10
200 0
Yen, trillions 70
60
50 Bills*
Futright 40 30
20 cer
10
0
100 Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul- Jul96 97 98 99 00 01 02 03 04
0 * Source BoJ * Teiat Bills tr,,m financial misu ins I bill. u luin corp debt obig ton,
urt la sedi t'll n lunci.tl M in ttumlns
Changes in the Japanese Government Bill Curve Since the Start of Quantitative Easing
Bid-to-Cover Ratio 7
6 5 4 \
Bid-to-Cover Ratio 7
0 0 3-nAnth 6-n-nth-
Yen,
Basis points 10 t
Basis points , 10
Apr-04 Jun-04 Aug-04 Oct-04 Dec-04 12-nwnth 2-vear
February 1-2, 2005 149 of 177
Daily Intra-Day Standard Deviations of the Federal Funds Rate 1987 -2004
Annual av erages of dailyx alus_
Annual medians of daily values
-x l r'; -t v. h -4 r
Average Intraday Standard Deviation of Federal Funds Rates (Maintenance Period Averages)
For Maintenance Periods Ending January 21, 2004 - January 19, 2005
FOMC Unch.
FOMC Unch. FOMC
Unch.
- tx - r-~ - Cl ^ Cl f'- - NC- -1 77 ~ 1 1 r r
FOMC +25 bps
FOMC 25 bps
FOMC +25 bps
rr -- t x n
Year End
FOMC FOMC -25 bps 25 bps
I-l -----,-
Page 5
Percent 0.40
0.35 -
0 30
0.25
0.20
0.15
005
0 00
Bai .4
Basis Points
February 1-2, 2005 150 of 177
Appendix 3: Materials used by Messrs. Slifman and Struckmeyer, and Ms. Johnson
February 1-2, 2005 151 of 177
STRICTLY CONFIDENTIAL (FR) CLASS I-FOMC*
Material for
Staff Presentation on the Economic Outlook
February 2, 2005
*Downgraded to Class II upon release of the February 2005 Monetary Policy Report.
February 1-2, 2005 152 of 177
Private Payroll Employment
Average monthly change, thousands
2002 2003 2004
Chart 1
:ent Indicators
Manufacturing Industrial Production
250 Percent change, a.r.
200
150 1972-2003 4 100 average
50
0
-50
-100 2002 2003 2004
Real PCE exc. Motor Vehicles* Sales of Light Vehicles
In this and subsequent charts, NIPA series in 2004:Q4 are from the January Greenbook.
Orders and Shipments of Nondefense Capital Goods*
Billions of dollars 65 3-month moving average Dec.
Orders 62 Dec. percent change
Shipments 2.2 59
Orders 1.8
56
Shipments 53
2003. .0502002
*Excluding aircraft.
Millions of units, a.r.
2002 2003
Real GDP
2004
Percent change, a.r.
2004:Q4
Jan. GB BEA
1. Real GDP 3.5 3.1
Contributions (percentage points)
2. Final sales 2.7 2.7
3. Inventories .8 .4
i . . . I . . . I . . . i
2003 2004
February 1-2, 2005 153 of 177
February 1-2, 2005 154 of 177
February 1-2, 2005 155 of 177
February 1-2, 2005 156 of 177
February 1-2, 2005 157 of 177
February 1-2, 2005 158 of 177
February 1-2, 2005 159 of 177
February 1-2, 2005 160 of 177
February 1-2, 2005 161 of 177
Chart 10
Financial Developments
60
70
80
90
100
110
Nominal Exchange RatesForeign currency/U.S. dollar
Major currencies*
Euro
Yen
2002 2003 2004 2005*Trade-weighted average against major currencies.
(Monthly data)
Index, Jan. 2002 = 100
0
2
4
6
Ten-Year Interest Rates
United States
Japan
Germany
2002 2003 2004 2005
Percent
0
1
2
3
4
Three-Month Interest Rates
Dollar
Yen
Euro
2002 2003 2004 2005
Percent
1
2
3
4
5
Term Structure of Three-Month Euro Futures
February 1, 2005
January 27, 2004
June 29, 2004
2004 2005 2006 2007
Percent
50
70
90
110
130
Broad Stock Price Indexes
S&P 500
TOPIX
DJ Euro Stoxx
2002 2003 2004 2005
Index, Jan. 2002 = 100
-1
0
1
2
3
Term Structure of Three-Month Yen Futures
February 1, 2005
January 27, 2004
June 29, 2004
2004 2005 2006 2007
Percent
February 1-2, 2005 162 of 177
Chart 11
Foreign Outlook
2003 2004-30
-20
-10
0
10
20
UnitedKingdom
EuroArea
Japan
Quarterly
Business ConfidencePercent balance
2003 200430
35
40
45
50
-20
-15
-10
-5
0
UnitedKingdom
EuroArea
Japan
Quarterly
Consumer Confidence Diffusion index Percent balance
2003 200485
95
105
115
125
UnitedKingdom
EuroArea
Japan
Monthly
ExportsIndex, Jan. 2003 = 100
Foreign Real GDP*Percent change, a.r.**
* Aggregates weighted by shares of U.S. exports.** Year is Q4/Q4; half year is Q4/Q2; quarters are percent change from previous quarter.
2004 2005 2006 Q3 Q4 Q1 Q2 H2
1. Total Foreign 2.6 3.1 3.0 3.3 3.4 3.3
2. Industrial Countries 1.9 2.0 2.1 2.4 2.5 2.4 of which: 3. Japan 0.2 1.0 1.2 1.4 1.6 1.8 4. Euro Area 1.1 1.4 1.4 1.5 1.6 1.6 5. United Kingdom 1.8 3.0 2.1 2.6 2.6 2.2 6. Canada 3.2 2.2 2.6 2.9 3.2 3.0
7. Emerging Economies 3.8 4.8 4.4 4.6 4.6 4.5 of which: 8. China 10.1 11.2 7.1 7.1 7.1 7.5 9. Emerging Asia exc. China 3.2 3.9 4.2 4.6 4.4 4.210. Mexico 2.6 4.0 4.0 4.1 4.2 4.311. South America 4.1 3.8 3.8 3.8 3.7 3.6
February 1-2, 2005 163 of 177
Chart 12
Emerging Market Economies
0
500
1000
1500
2000
2500
0
100
200
300
400
500
600
* The series shown are the EMBI+ Brazil sub-index, the EMBIGlobal Thailand sub-index, and the Indonesian Yankee Bond Spread.
2002 2003 2004 2005
Brazil
Thailand
Indonesia
Weekly
Spreads* Basis points Basis points
50
75
100
125
150
175
200
2002 2003 2004 2005
Brazil
Korea
Singapore
Weekly
Stock Price IndexesIndex, Jan. 4, 2002 = 100
95
100
105
110
115
120
125
130
135
2003 2004
China
Korea
Thailand
Monthly
Industrial ProductionIndex, Jan. 2003 = 100
90
110
130
150
170
190
2003 2004
China
Korea
Thailand
Monthly
ExportsIndex, Jan. 2003 = 100
95
100
105
110
115
2003 2004
Mexico
Brazil
Monthly
Industrial ProductionIndex, Jan. 2003 = 100
80
100
120
140
160
180
2003 2004 2005
Mexico
Brazil
Monthly
ExportsIndex, Jan. 2003 = 100
February 1-2, 2005 164 of 177
Chart 13
Trade Developments
* Excludes oil.** Average of October and November data.
Q3 O-N** Change
1. Balance -621 -698 -77
Imports: 2. G & S 1780 1858 78 3. Cons. Gds. 365 386 21 4. Machinery 180 182 2 5. Ind. Sup.* 241 244 3 6. Oil 180 220 40 7. Other 814 826 12
Exports: 8. G & S 1158 1160 2 9. Machinery 169 165 -410. Ind. Sup. 190 195 511. Other 799 800 1
Trade in Goods and ServicesBillions of dollars, a.r.
120
140
160
180
200
220
2002 2004
Canada
W. Europe
Goods Exports By RegionBillions of dollars, s.a.a.r.
20
40
60
80
100
120
2002 2004
Other Latin America
Mexico
0
20
40
60
80
100
2002 2004
Japan
China and Hong Kong
60
80
100
120
140
160
2002 2004
Other Asia
10
20
30
40
50
60
2002 2004 2006
WTI spot price
U.S. import price
Trade Prices Oil Prices
Dollars per barrel
2002 2003 2004 2005 2006-4
-2
0
2
4
6
8Contribution of foreign prices in US$Contribution of commodity pricesCore import price
Core Import PricesPercent change, a.r.
February 1-2, 2005 165 of 177
Chart 14
External Sector
2004 2005 2006-3
-2
-1
0
1
2
3ExportsImports
Contributions to U.S. GDP GrowthPercentage points
65
75
85
95
105
2002 2004 2006
GB baselineAlternative simulation
Broad Real DollarIndex, 2002:Q1 = 100
-900
-800
-700
-600
-500
-400
-300
2002 2004 2006
Trade balanceCurrent account balance
External BalancesBillions of dollars
2004Q4 2006Q4 Change
Trade balance baseline -689 -720 -31 weaker dollar -689 -689 0
Current account balance baseline -774 -881 -107 weaker dollar -774 -863 -89
Simulation ResultsBillions of dollars
Real Export GrowthPercent, Q4/Q4
*Excludes computers and semiconductors.
2003 2004 2005 2006
1. Goods and 6.1 4.9 8.7 7.2 services
Percentage point contribution:2. Services 1.2 1.4 2.0 1.83. Goods 4.9 3.5 6.6 5.4 of which4. Core* 3.0 3.5 5.1 3.9
Real Import GrowthPercent, Q4/Q4
*Excludes computers, semiconductors, and oil.
2003 2004 2005 2006
1. Goods and 4.9 9.3 5.2 7.6 services
Percentage point contribution:2. Services 0.6 0.3 0.6 0.73. Goods 4.2 9.0 4.6 6.9 of which4. Core* 3.3 6.7 4.5 5.6
February 1-2, 2005 166 of 177
Chart 15
ECONOMIC PROJECTIONS FOR 2005
FOMC
Range CentralTendency
Staff
-------------Percentage change, Q4 to Q4------------
Nominal GDP July 2004
Real GDP July 2004
Core PCE Prices July 2004
5 to 6 (4¾ to 6½)
3½ to 4(3½ to 4)
1½ to 2
(1½ to 2½)
5½ to 5¾(5¼ to 6)
3¾ to 4(3½ to 4)
1½ to 1¾(1½ to 2)
5.4(5.0)
3.9(3.6)
1.6(1.6)
--------------Average level, Q4, percent---------------
Unemployment rate July 2004
5 to 5½(5 to 5½)
5¼(5 to 5¼)
5.3(5.3)
Central tendencies calculated by dropping high and low three from ranges.
ECONOMIC PROJECTIONS FOR 2006
FOMC
Range CentralTendency
Staff
-------------Percentage change, Q4 to Q4------------
Nominal GDP Real GDP
Core PCE Prices
5 to 5¾
3¼ to 3¾
1½ to 2
5 to 5½
3½
1½ to 1¾
5.3
3.6
1.4
--------------Average level, Q4, percent---------------
Unemployment rate 5 to 5¼
5 to 5¼
5.1
February 1-2, 2005 167 of 177
Appendix 4: Materials used by Mr. Olson
February 1-2, 2005 168 of 177
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Seasonal Factors Out of 100 percent)
All Insured Commercial Banks Banks L T $1 billion 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q
NPA Ratio 101 .3 100.2 100.6 97.9 NPA Ratio 101 .7 99.9 100.5 97.8 Net Net ICharge-oft Charge-off Ratio 90.2 96.6 96.3 116.7 Ratio 76 .0 92.4 91 .7 139.7
Prev to Prev to Avg Loans 91.9 94.6 98.9 11 4.3 Avg Loans 85.3 92 .5 97.7 124.4
Total Mean S.D. Total Mean S.D.
NPA Ratio 105.94 1.80 1.32 NPARatio 80.55 1.37 0.74 Net Net Charge-off v harge-off Ratio 51 .75 0.88 0.35 Ratio 26 .54 0.45 0.18
Prev to Prov to Avg Loans 54.21 0.92 0.38 Avg Loans 34.19 0.58 0.22
February 1-2, 2005 171 of 177
Seasonal Factors Out of 100 percent)
All Insured Commercial Banks Banks L T $1 billion 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q
NPA Ratio 101 .3 100.2 100.6 97.9 NPA Ratio 101 .7 99.9 100.5 97.8 Net Net ICharge-oft Charge-off Ratio 90.2 96.6 96.3 116.7 Ratio 76 .0 92.4 91 .7 139.7
Prev to Prev to Avg Loans 91.9 94.6 98.9 11 4.3 Avg Loans 85.3 92 .5 97.7 124.4
Total Mean S.D. Total Mean S.D.
NPA Ratio 105.94 1.80 1.32 NPARatio 80.55 1.37 0.74 Net Net Charge-off v harge-off Ratio 51 .75 0.88 0.35 Ratio 26 .54 0.45 0.18
Prev to Prov to Avg Loans 54.21 0.92 0.38 Avg Loans 34.19 0.58 0.22
Appendix 5: Materials used by Mr. Reinhart
February 1-2, 2005 172 of 177
Restricted Controlled (FR) Class I (FOMC)
Material forFOMC Briefing on Monetary Policy Alternatives
Vincent R. ReinhartFebruary 2, 2005
February 1-2, 2005 173 of 177
Exhibit 1The Case for Tightening 25 Basis Points
Expected Federal Funds Rate
F February 1, 2005-------- December 13, 2004- - - Greenbook path
Percent
h/i' 1 1 1 l iI i mll II I I I AFeb. May Aug. Nov. Feb. May Aug. Nov.
2005 2006
Corporate and Sovereign Bond Spreads*Basis points Basis points
5-year High Yield (left scale)------ EMBI (right scale)
I I I I I I I I I I I I I I
Unemployment Rate Percent
3.2 1990 1993 1996 1999 2002 2005
3.0 Core PCE Inflation Percent
1990 1993 1996 1999 2002 2005
Asset Prices and Monetary Policy
* Asset price misalignments are hard toidentify with confidence.
* Appropriate monetary policy is not clear.
* Other instruments may be better suitedto dealing with such problems.
1990 1992 1994 1996 1998 2000 2002 2004
*Spreads over yields on comparable maturity Treasuries.
Values from Policy Rules and Futures MarketsPercent
- Actual federal funds rate and Greenbook assumption.... Market expectations estimated from futures quotes
An explanatory note is provided in Chart 9 of the Bluebook.
1200
1000
800
600
400
2nn200
Monthly
February 1-2, 2005 174 of 177
Exhibit 2When Will You Stop Tightening?
Market Participants Assume:
* Policy will be tightened 25 bps at everymeeting.
* Until this tightening cycle ends.
* They are uncertain as to when tightening willend.
Cumulative Probability of First FOMC MeetingWithout Tightening Probability
3.50
3.25
3.00
2.75
2.50
2.25
Aug Nov Feb May Aug Nov 2007+2006
First FOMC meeting without tightening
Percent
Range ofdates of
finaltightening
After Nov. 06
Aug. 06 - Nov. 06
Feb. 06 - Jun. 06
Aug. 05 - Dec. 05
Feb. 05 -Jun. 05
1.00
0.75
0.50
0.25
0.0
Median Path for Policy Percent
Feb. Mar. May Jun. Aug. Sep. Nov. Feb May A
2005 2005First F
Range of Estimated Equilibrium Real Rates
S Range of model-based estimates - Actual real federal funds rateS70 percent confidence band - - Greenbook-consistent measure
[i 90 percent confidence band
lit I. Ill 111111 .I I.. I III I I Il . 11111. 111 I I II1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
An explanatory note is provided in Chart 8 of the Bluebook.
- "
February 1-2, 2005 175 of 177
Exhibit 3
Assessing the Risk Assessment
From the FOMC Statement released December 14 th
The Committee perceives the upside and downside risks to theattainment of both sustainable growth and price stability for thenext few quarters to be roughly equal. With underlying inflationexpected to be relatively low, the Committee believes that policyaccommodation can be removed at a pace that is likely to bemeasured. Nonetheless, the Committee will respond to changes ineconomic prospects as needed to fulfill its obligation to maintainprice stability.
Three alternatives
1. Get out of the business of hinting-either obliquely ordirectly-about future actions by dropping the entireparagraph.
2. Revive the first sentence assessing risks by basing it on theassumption of an unchanged stance of policy for the next fewquarters and couching it in terms of probabilities, not risks.
3. Rely on the gradual evolution of the latter part of theparagraph to convey a sense of the future path of interestrates.
February 1-2, 2005 176 of 177
Table 1: Alternative Language for the January FOMC Announcement
December FOMC Alternative A Alternative B Alternative C
1. The Federal Open Market Committee The Federal Open Market Committee The Federal Open Market The Federal Open Market Committeedecided today to raise its target for the decided today to keep its target for the Committee decided today to raise its decided today to raise its target for the
Policy federal funds rate by 25 basis points to federal funds rate at 2¼ percent. The target for the federal funds rate by federal funds rate by 50 basis points toDecision 2¼ percent. Committee's policy actions since mid- 25 basis points to 2½ percent. 2¾ percent.
2004 have materaily reduced the degreeof monetary policy accommodation.
2. The Committee believes that, even The Committee believes that the stance The Committee believes that the stanceafter this action, the stance of of monetary policy remains somewhat Unchanged from of monetary policy remainsmonetary policy remains accommodative and, coupled with robust accommodative and, coupled withaccommodative and, coupled with underlying growth in productivity, is [DEL: robust] the underlying growth inrobust underlying growth in providing ongoing support to economic productivity, is providing ongoing
productivity, is providing ongoing activity. support to economic activity.
support to economic activity.
Rationale 3. Output appears to be growing at a Output appears to be growing at a Output appears to be growing at a Output appears to be growing at amoderate pace despite the earlier rise moderate pace despite the [DEL: earlier] rise in moderate pace despite the [DEL: earlier] moderate pace despite the [DEL: earlier] rise inin energy prices, and labor market energy prices, and labor market rise in energy prices, and labor energy prices, and labor marketconditions continue to improve conditons seem to be improving market conditions continue to conditions continue to improvegradually. gradually improve gradually. [DEL: gradually].
4. Inflation and longer-term inflation Unchanged from IUnchanged from Inflation and kiatctIerter inflationexpectations remain well contained. December statement] December statement expectations remain well contained, but
rsing business costs have the potentialto put upward pressure on prices.
5. The C:ommittee perceives the upside
and downside risks to the attainment I[Unchanged from IUInchanged from (U nchanged fromof both sustainable growth and pricestability for the next few quarters tobe December statement December statement] December statement]
roughly equal.
6. W\ith underlying inflation expected to W\ith underlying inflation expected to beAssessment be relatively losw, the Committee relatively low, the Committee believes
of Risk believes that policy accommodation that policy accommodation can becan be removed at a pace that is likely removed at a pace that is likely to be [Unchanged from Noneto be measured. Nonetheless, the measured. Nonetheless, the Committee December statement]
Committee will respond to changes in will respond to changes in economic
economic prospects as needed to fulfill prospects as needed to fulfill its
its obligation to maintain price obligation to promote price stability and
stability. sustainable growth.
February 1-2, 2005 177 of 177